Investment Consult: Patience--the best cure for market jitters

February 19, 2001

Your portfolio is more likely to thrive if you resist the urge to trade frequently.

 

Investment Consult

Patience— the best cure for market jitters

Your portfolio is more likely to thrive if you resist the urge to trade frequently.

By Lewis J. Altfest, PhD, CFA, CFP

With the Nasdaq off significantly from its high and the Dow Jones Industrial Average struggling as well, you may be tempted to dump many of your stocks and mutual funds. Instead, you should not only hold on, but perhaps buy more.

If you're inclined to sell at times like this, you're not alone. Many investors hold their stocks and funds for shorter periods these days, in part because they've made quick money trading hot issues, or someone they know has. Even professional managers of domestic stock funds haven't been immune to the lure of short-term investing; turnover has risen significantly over the past year.

If you're acting on solid information, moving rapidly in and out of stocks isn't necessarily bad. But therein lies the rub: A smart analyst once told me that an investor can potentially know only about 25 percent of all the factors that drive a stock's price. Nevertheless, some of my clients are certain they know all of them. I can't tell you how many times someone was sure a stock was going to be the next big winner, only to see it plummet within six months. Finance professors with a psychological bent call basing long-term conclusions on short-term information "myopic behavior."

Another indicator that active trading doesn't pay off: Men tend to trade stocks more often than women, yet annually men net 1.4 percent less than women, according to researchers Brad M. Barber and Terrance Odean of the University of California at Davis. Barber and Odean looked at account data from more than 35,000 households that used a large discount brokerage firm. The differences in returns, they found, were most pronounced between single men and women. In this group, men traded 67 percent more often than women—and netted 2.3 percent less annually.

The reason men trade more? Overconfidence in their financial knowledge, said Barber and Odean, based on their research and on conclusions of previous studies. The Web also seems to have contributed to an increase in trading. Barber and Odean conducted a separate study that showed that online investors tend to trade more actively and have worse returns than they did before switching to a computer-based account.

Whatever the cause, active trading isn't going to help your portfolio over the long haul. If you think you're becoming a tad overzealous with your investments, or find yourself getting burned a bit too often, follow these suggestions before selling:

  • Look at the investment's vitals going back at least several years. For both stocks and mutual funds, Yahoo! Finance (finance.yahoo.com) and Morningstar.com (www.morningstar.com) are invaluable—and free—resources. You may also find one of my favorite resources, The Value Line Investment Survey,* at your public library; or you can order your own copy (800-535-2947; www.valueline.com). Measure the performance of the stock or fund against its peers, not the broader market.

  • Ask yourself what you know about the investment that isn't reflected in its price. In other words, if it's cheap, why is it cheap? It might be a poor investment, or a good one that's selling at a discount.

  • Never take at face value alarming news posted in Internet chat rooms. Scam artists use this tactic to manipulate stock prices and take profits. Always check the information with trusted sources.

Don't give up on a sensible investment during tough times. More and more, the markets are making dramatic swings from day to day. Some financial-news media—even the ones that do a good job of educating investors—tend to overstate the importance of short-term happenings. If you find yourself frequently changing your opinions of your holdings, don't examine your investments every day. Once a week is plenty for stocks; once a quarter is enough for funds.

Also, be alert for material changes in a company's or a sector's outlook. If, for instance, a company reports disappointing earnings, check one of the financial resources I've mentioned to see whether future earnings are expected to suffer. Likewise, re-evaluate your position if the company's CEO departs or a lot of insiders sell the stock.

Finally, don't bail out of a stock just because its price is down. A price drop can point to problems, but not always, as when a large institution sells its position to raise capital or meet financial obligations. Greet any spike or drop in price as an opportunity to re-examine the stock, and possibly to reaffirm your confidence in it. (For more on when to sell an investment, see Investment Consult, April 24, 2000.)

Fairly recently, I thought about unloading my shares in a closed-end fund that concentrates on India. At the time, the price was sinking due to the country's poor political environment. Naturally, I wasn't happy, but the long-term reasons for holding the security remained intact. I hung in, and even added shares while the price was cheap. A few months later, the Indian government stabilized, and the value of my original shares more than doubled.

*See Investment Consult, Jan. 22, 2001.

 

The author, a fee-only financial planner, is president of L.J. Altfest & Co.(www.altfest.com ), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

 

Lewis Altfest. Investment Consult: Patience--the best cure for market jitters. Medical Economics 2001;4:28.